Why would an investor buy a ground lease, when the CAPs seem lower and you don't get the benefit of deprec?

Deciding between NNN purchase or Ground Lease purchase. GL's seem to be trading at a lower cap. First off, why? Second off, why not buy the NNN deal and get the benefit of depreciation?
In Buying Property - Asked by Raja K. - Jan 5, 2010
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Andy R.
New York, NY

Owning the building and land outright (fee interest) is better than owning a building on top of a groundlease (groundlease interest). At the end of the groundlease the groundlessor takes ownership of the building you own. So you can think of a groundlease as additional debt on the property, which is why pricing would be lower.
I am not a tax expert but my understanding is you can depreciate a building if it is subject to a ground lease. In fact if it is a short groundlease you can amortize on that basis. Good luck Andy 917-749-8251

Jan 5, 2010
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Chris R.
Newport Beach, CA

Ground Lease's trade at lower cap rates because they offer security in the form of the improvements. When you buy a ground lease you are leasing the land to a tenant knowing that the building will revert back to you should they leave. Most tenants are not going to vacate a building that they just spent hundreds of thousands of dollars on unless they have no choice (bankruptcy), thus offering a higher level of security to your income stream. The ground rent of a property is typically much lower than the rent attainable if one was to own the fee (both building and land), so should a tenant default or vacate on a ground lease the property owner should be able to command a higher rental figure (for the building and land) at the basis which they purchased just the land at (which should increase their rate of return). To answer your second question, if your seeking depreciation then a ground lease is not your deal. Leasehold deals are 100% depreciable, but your losing your investment to the ground lessor at the end of the term, so the CAP rate should be much higher and have plenty of term remaining. NNN fee simple deals will offer you depreciation, just make sure the rent is sustainable and the tenant is credit worthy.

-Adam www.pacificnnn.com

Jan 5, 2010
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Ian F.
Newport Beach, CA

Raja, I think you are talking about a "Leased Fee" vs. "Fee Simple" ownership. Simply put, in a "Leased Fee" arrangement for tax purposes you would own the land but not the building. As mentioned earlier the building would revert back to you at the end of the Lease term (because they can't take it with them). You are correct that you cannot enjoy cost recovery (depreciation) under this arrangement because you do not own the building. In a Fee Simple arrangement you own both the land and the building and CAN depreciate the value of the building over a 39 year straight line depreciation period. As always the devil is in the details. With regards to the potential pricing difference - I have seen very little value given in the marketplace to the nuance of depreciation that you mention. In my experience if you had two identical deals but one was a Leased Fee and the other a Fee Simple, both would find buyers willing to pay close to identical amounts. Why? I think it is generally a lack of understanding. Once again, all things being equal, to me the Fee Simple deal would clearly be more attractive with a better after tax return. I don't think the marketplace accurately values depreciation within the cap rate. In any event, pay particular attention to the costs associated with the building, and in either form of ownership who (LL or Tenant) is responsible for what.
Either way Raja, it appears you'll do fine. You've addressed an issue that surprisingly few investors value and/or understand.
Best of Luck!
Post Script: I've attached a link to a NNN property I just listed yesterday that is a perfect example of what you are talking about. This property is a unique combination of both the depreciation benefits of Fee Simple ownership (both land and building), coupled with the hassle free maintenance of a Leased Fee property. The Lease in place with the tenant is a "Ground Lease" but the Tenant is also responsible for all maintenance of the building including roof and structure. The Landlord owns the building, gets to depreciate the building, but is not be hassled with the effort, cost or responsibility of the upkeep.

Jan 7, 2010
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Marie M.
Putnam Valley, NY

Can improvements on a ground lease be depreciated?

Oct 4, 2011
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